[자본시장 속으로] How to identify companies that are losing money due to inventory backlogs

As the economy continues to slow down, inventory burdens for companies are increasing. Inventory refers to goods and products held for sale, raw materials and semi-finished products used in the production process. Companies use the term inventory when presenting this inventory on a statement of financial position. What is the reason for attaching ‘asset’ to inventory?

An asset is defined as a resource from which future economic benefits are expected to flow to the entity. In simple terms, if you expect to make money in the future, you call it an asset. The company pays a lot of money while buying products and raw materials. In addition to material costs, labor costs and expenses are input for the production of products. In fact, the inventory shown on the statement of financial position is a lump of expense. Still, the company treats inventory as an asset, not an expense. Because, as much as you put so much money into it, there is an expectation that you will make more money than that amount. Otherwise, it does not deserve to be an asset.

The company accounts for the cost of raw materials, labor, and other expenses spent for product production as inventory assets and stores them, and when sales are made, expense is accounted for as cost of goods sold. We refer to this cost of sales plus margin as sales revenue. In other words, if the company is storing after production, it is inventory, and if it is sold, it is cost of goods sold. It is not uncommon to hear that companies are backlogged in inventory. If you want to know how much inventory is accumulated, you can compare inventory balance and cost of sales.

K Semiconductor, which was in full swing, faced the theory of crisis, and one of the reasons is the backlog of inventory. According to SK Hynix’s business report, the amount of inventory held at the end of 2022 is 17 trillion won, an increase of about 85% from 9.2 trillion won at the end of 2021. As sales have increased, it can be expected that inventory will also increase. In 2022, the cost of sales will be about 28 trillion won, and if you divide this by 12 months, you can calculate that the average monthly cost of sales is about 2.3 trillion won. Since the inventory assets held are 17 trillion won, it has about 7.3 months of inventory. Compared to having 4.6 months worth of inventory at the end of 2021, it has accumulated a lot.

The problem is that the sales outlook for 2023 is not optimistic due to falling DRAM prices and sluggish demand. In fact, if you look at the average of SK Hynix’s 2023 earnings forecasts predicted by various securities companies, sales were expected to decrease by 47% from 2022 to 24 trillion won, and the operating loss was expected to exceed 10 trillion won. It means that if you sell the product, you will lose money.

What should I do in accounting when the inventory accumulated in the warehouse is no longer sold or sold at a loss? It was recognized as an asset because it was expected that it would make money for the company by selling it for more than the cost of production, but now that is impossible, the logic is that inventory should not be regarded as an asset. Thus, firms immediately write a loss on inventories that are not sold or that are expected to sell below cost. This is referred to as inventory valuation loss and is added to cost of sales.

SK Hynix’s 2022 income statement shows that about 29 trillion won was accounted for as cost of sales, including 28 trillion won sold based on cost and 1 trillion won treated as loss on valuation of inventory assets. Several other companies also dealt with a lot of inventory valuation losses while closing their accounts in 2022. Samsung Electronics treated 4.4 trillion won as a loss on valuation of inventory assets, an increase of 2.5 trillion won from the previous year, and LG Electronics also recorded a loss of 341.7 billion won, nearly twice that of 2021.

In times like this, companies need to be more sophisticated in demand forecasting and perfect inventory management while properly controlling production. From a shareholder’s point of view, it is necessary to numerically verify whether the company’s inventory management is working well. As mentioned in the text, the amount of inventory held at the end of the year at the monthly cost of sales is about several months, and if you review whether it is at a good level compared to the past or the same industry, you can check whether the company’s inventory is selling well or not and is stacking up in the warehouse. .

If the inventory turnover rate drops when all cash has already been injected for production, it has a great adverse effect on the cash flow of the company.